Fixed Income: Popular myths debunked | Insight Investment

We address four myths that can mislead investors about the potential for liquid bonds to deliver significant value in the current environment.

Myth 1: Passive investing is always the way to go

Reality: Over the last 10 years, active fixed income managers have fared better (vs passive) than equity managers.

Active equity strategies have struggled against their passive counterparts, but active core bond managers have fared better (Figure 1).

Figure 1: Active fixed income strategies have fared better than passive strategies over 10 years¹

In our view, this reflects structural inefficiencies in bond indices, which natrally allocate their highest weights to the most indebted companies (because those have the most outstanding bonds). Active investors (that are not captive to benchmark weights) can aim to structure portfolios more deliberately from the ground up, potentially avoiding adverse selection risks.

Active high yield managers have also tended to outperform passive strategies, but both have struggled against the broadest high yield indices themselves (Figure 2). We believe this reflects lower market liquidity and trading frictions. To overcome them, investors may wish to consider a systematic approach that makes use of “credit portfolio trading”, a highly liquid trading protocol.

Figure 2: A systematic approach may be able to target value in high yield more effectively²

Myth 2: Market volatility is always bad for fixed income investors

Reality: Volatility can create alpha opportunities for active managers. Absent default risk, it can be irrelevant for cashflow seekers.

Volatility can be painful for risk assets, but in bonds, it can create value through market dislocations (particularly when default risks do not rise). Historically, active fixed income managers have delivered more alpha through volatile markets than stable ones (Figure 3).

Figure 3: Active managers have tended to perform better through volatile markets³

Over time, we believe volatility has been exacerbated by the rise of passive investment, which has grown from a 21% to 39% AUM share of all global fixed income mutual funds and ETFs over the last 10 years⁴. Passive strategies tend to retain the inefficiencies of bond indices. They also suffer waves of simultaneous forced selling when bonds are downgraded from investment grade to high yield and are typically forced to sell indiscriminately across their holdings, regardless of value, when facing redemptions.

In our view, managers that prioritize credit selection and relative value opportunities (across issuers, yield and credit curves, sectors and regions) will have the most potential to convert bouts of volatility into potential long-term alpha.

Further, it is important to remember that bond returns are contractual and pre-determined (paid via coupons and principal repayments). For investors holding until maturity, volatility in the secondary market will not impact those returns (absent default), which is important to note for those looking to structure portfolios to match cashflow needs with a high degree of certainty.

Myth 3: Timing fixed income markets is key

Reality: “Time in the market” may beat “timing the market”

While volatility can create opportunities in fixed income, waiting for holistic market sell-offs before investing can be costly.

Every moment an investor waits, they give up on accruing income, which has historically been the major driver of bond market returns. This is potentially why we find that “range trading” the Bloomberg US Corporate Bond Index over the last 10 years would have likely underperformed the index itself over the long term in most cases, even when ignoring transaction costs (Figure 4)

Figure 4: Timing the market in high yield may be less profitable than staying invested⁵

For investors concerned about market sell-offs causing rates and spreads to spike, we believe they should consider the 12-month “breakeven” yield levels that would likely bring 12-month total returns to zero.

For example, US investment grade all-in yields would need to rise by 70bp for 12-month price returns to cancel out income returns. For US high yield, it would require a more onerous 2.4% yield rise⁶ (ignoring defaults). In our view, those comfortable with those scenarios should consider allocating to these asset classes now rather than waiting.

Myth 4: Private debt is where all the value is

Reality: Liquid bonds may offer advantages and value between public and private debt can wax and wane

In our view, liquid public credit may have some underappreciated advantages over its higher yielding, less liquid cousin.

Liquid strategies have greater latitude to take advantage of market volatility. While private credit may be attractive in durable industries with ample book assets, 20% of US business development companies are exposed to software sector debt⁷, an industry light on hard assets and potentially vulnerable to disruption amid the AI investment boom.

Rising credit risk may also be a concern for private credit. Leveraged buy-outs are increasingly funded in private credit instead of leveraged loans or high yield (Figure 5, left). We have also noted a trend of lower-rated issuers using private credit to refinance outstanding public credit, which could lead to an increase in private credit defaults and a decrease in public defaults.

Further, there are signs that these additional risks have not been met with a widening illiquidity premium on private credit, which may even have narrowed in recent years, as indicated by euro market data (Figure 5, right).

Figure 5: Private credit may be taking on public credit’s riskiest debt without a wider illiquidity premium⁸

Conclusion: Don’t be held back by popular fixed income myths

In our view, fixed income remains attractive in the current yield environment. However, given the relatively narrow spread environment, active or systematic management can be crucial in our view to maximizing potential value.

In today’s evolving market, many long‑held assumptions about fixed income may no longer hold. We believe a flexible, research‑driven approach can help investors capture potential opportunities across the risk/return spectrum.